Newcomers Challenge Office-Supply Stalwarts

By JOSEPH PEREIRA and ANN ZIMMERMAN | WSJ.com
4/29/2009

In the grinding recession, companies are finding ways to save even on the cost of the lowly office pen. And that has created an opening for discounters to steal business from the office-supply industry's big three.

Online discounters and retail giants such as Wal-Mart Stores Inc. and Costco Wholesale Corp. are cranking up their efforts to woo customers of the big office superstore chains -- Staples Inc., Office Depot Inc., and OfficeMax Inc. The result: a wave of price-competition that is benefiting lower-cost vendors and encouraging companies to switch suppliers. Wal-Mart's Sam's Club, a warehouse-store chain, last month began sending employees to small businesses to compare office-supplies prices, and plans to provide cost comparisons for 100,000 businesses by late May.

The result: a wave of price-competition that is benefiting lower-cost vendors and encouraging companies to switch suppliers.

Count Me In for Women's Economic Independence, a New York group that promotes women entrepreneurs, switched its business to Sam's Club after a review of its Staples invoices. "It turns out we'll be saving more than $7,000 on an annual basis,"said Nell Merlino, president and chief executive.

Costco this summer will open its ninth warehouse store dedicated to selling supplies to small and mid-sized businesses. The Issaquah, Wash., retailer has seen "double-digit" sales growth from the centers, which are often located near office parks.

"Office superstores do a better job of contract pricing for large companies. We do more small and medium-sized offices," said Phil Lind, vice president of Costco Business Centers. Costco's sales of office products are projected to hit $1.25 billion in its current fiscal year, a small portion of its total sales, which last fiscal year were $72.5 billion.

Still, the recession has taken a toll on the larger office-supply companies, who have had to retrench amid uncertain demand. Office Depot on Tuesday swung to a quarterly loss after taking a hefty restructuring charge.

Declining sales prompted the company to halve its plans for 2009 new-store openings and close several underperforming stores and distribution centers.

Office Depot reported a net loss of $55.3 million, or 20 cents a share, for its fiscal first quarter ended March 28, compared with year-earlier net income of $68.6 million, or 25 cents a share. But excluding the restructuring and other charges, the company said it would have earned $27 million, or 10 cents a share.

Revenue fell 19% to $3.23 billion.

There are signs, however, that the environment may be stabilizing. The company said same-store sales in North America weren't as bad in its first quarter as in the previous quarter -- a sign that consumer confidence is gaining momentum after months of sluggish sales. Combined sales at Staples, Office Depot and OfficeMax fell 5.5% last year, excluding Staples's acquisition of Corporate Express, which had been No. 4 in the industry.

The three office superstore chains still dominate the business with a combined $41.6 billion in annual sales -- out of an estimated $100 billion market. They generally boast margins of 25% to 28% of sales, a fat plum to newer rivals looking to undercut them on prices.

Supplies can be lucrative. Office furniture carries pretax gross margins of as much 60%, desk and legal calendars from 30% to 60%, and pens about 20%.

Tony Ellison, president of online discounter Shoplet.com, said the downturn is encouraging more companies to try new suppliers. Sales at the New York-based retailer jumped to $100 million from $65 million in 2007.

Amazon.com Inc. launched its own office supplies store on its U.S. site in June 2008. "We were already in the business for ink and toner for printers," said Paul Ryder, an Amazon vice president. "We just said, 'Why don't we go all the way into office supplies?'"

As the economy worsened last summer, Tina Tuomikoski, a purchaser for Omaha-based investment firm CDM Service Group, dropped two national office-supply chains in favor of lower prices from online retailer Shoplet.com.

Ms. Tuomikoski estimates the move will save $30,000, or about 15%, this year for CDM, which has 260 employees. "In times like this it's a bargain too good to pass up," she said.

The three biggest chains all sell online, too. But Staples and Office Depot say that discount-seekers make up only a small percentage of total customers, and that their chains have significant advantages.

Among them: brand recognition, and store networks that let customers get supplies immediately, return goods faster, and allow customers to size up goods in person.

Most businesses "don't want to spend their time shopping the Web for who's got the cheapest price every time you need something," said Joseph Doody, president of Staples's North American delivery unit, which oversees the Massachusetts-based retailer's online sales.

Price is only one factor of the equation," added Monica Luechtefeld, executive vice president for of e-commerce at Office Depot, based in Boca Raton, Fla. "Our customers also want to know that if they have a problem we'll be there for them."

Office Max didn't return calls.

Earlier this year, when the city of Bandon, Ore., was looking for 300 metal chairs for a community center, it invited three retailers to enter bids: among them Staples and BizRhino.com Inc., an online retailer that launched its new Web site in February.

BizRhino's bid of $12,911.52 won out over a $14,726 bid from Staples, the city said. Rex Emami, director of operations for BizRhino.com, of Torrance, Calif., said he's still "making a good profit" on the Bandon sale because of lower overhead. His company has three employees.

Staples said the Bandon loss was a "one-time" event. The company's Mr. Dowdy said he's sticking by his company's business model. "I don't wake up in the middle of the night wondering if the world's coming to an end" because of the discounters, he said.

—Geoffrey A. Fowler and Katherine E. Wegert contributed to this article.